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Market Circuit Breakers

Before the
Senate Banking Committee

Statement for the Record
by the Investment Company Institute

February 11, 1998

The Investment Company Institute1 wishes to express its views on market circuit breakers. Recent events have prompted a long-overdue evaluation of the circuit breaker system. The ICI generally believes that circuit breakers, if appropriately structured, can serve an important function during periods of extraordinary market volatility by promoting the efficient operation of the markets and thereby protecting investors and the public interest. The current rules governing circuit breakers unfortunately fall short of those goals and, therefore, should be modified. Specifically, the ICI recommends that the circuit breakers be modified (1) by increasing the levels at which trading halts would be triggered and (2) by ensuring that markets close at their normal time in an orderly fashion on every trading day. These recommendations are discussed in greater detail below. We are pleased that the most recent proposal by the New York Stock Exchange (NYSE) goes a long way in meeting these objectives.

Increasing the Circuit Breaker Levels
The current circuit breaker levels of 350 and 550 points of the Dow Jones Industrial Average (DJIA) are not reflective of "extraordinary market volatility," as contemplated by NYSE Rule 80B. As a result, the circuit breakers can be triggered even in the absence of extraordinary market declines, as demonstrated on October 27th when the second level was reached and the market closed early even though the market was down only 7.2%. This is contrary to the intent of the circuit breakers and potentially harmful to investors and the public interest.

On February 5, the NYSE approved increasing the circuit breaker levels to ten, twenty, and thirty percent of the DJIA.2 We support adjusting the levels in this manner. In addition to increasing the triggers to more appropriate levels, this change would base the triggers on percentage changes in the market rather than on specified point changes. Basing the triggers on percentage changes will ensure that they correspond to significant changes in the markets and, therefore, will avoid the situation we are currently faced with— trigger levels that are severely outdated due to significant market growth.

Ensuring an Orderly Market Close
The NYSE’s proposal would allow for an early market close if the twenty percent level is reached after 2:00 pm or if the thirty percent level is reached at any time during the day. The ICI continues to believe that any trading halt that would cause the markets to close earlier than the normal 4:00 pm close should be avoided and that even during—and perhaps especially during—times of extraordinary market volatility, it is essential that the markets remain open for a sufficient period of time at the end of the day (e.g., an hour). Closing the markets prematurely will likely have the adverse effect of accelerating a decline, as some investors may feel compelled to try to sell before the close, rather than providing an opportunity for the markets to stabilize.

In addition, an early market close will be harmful to the over 60 million mutual fund shareholders who have come to expect that the markets will close at 4:00 pm. On a day that the market closes early, fund shareholders will be surprised and confused when they learn that they will not get that day’s net asset value for purchase and redemption orders placed before 4:00 pm.

Providing an orderly market close will also facilitate the ability of mutual funds to price their portfolios in a timely manner. In recent testimony, Chairman Levitt observed that, "Mutual funds cannot calculate daily net asset value without a market close from which to price. The absence of net asset values for mutual funds also could undermine general investor confidence in the financial markets. This underscores the importance of thinking very hard before concluding that markets should close early for the day." We agree with Chairman Levitt’s remarks.

Accordingly, the ICI continues to have concerns with those aspects of the NYSE’s proposed circuit breaker rules that could result in the markets closing prematurely. Nevertheless, we are pleased that under the NYSE’s proposal, this could only occur as a result of a market decline of 20% after 2:00 pm or 30% at any time during the day. This should greatly minimize the potential for an early close and thus avoid the deleterious effects noted above.

Thank you for your consideration of our views.

ENDNOTES

1The Investment Company Institute (ICI) is the national association of the American investment company industry. Its membership includes 6,860 open-end investment companies ("mutual funds"), 441 closed-end investment companies, and 10 sponsors of unit investment trusts. Its mutual fund members have assets of about $4.419 trillion, accounting for approximately 95% of total industry assets, and have over 62 million individual shareholders.

2These percentages would be converted on a periodic basis into point totals based on market closing prices over a specified time period.